Everyone Needs Risk Management

By Mike Patton Source: www.forbes.com

What is risk? Some say risk is a nasty four letter word that can ruin your life. Risk
management is serious business. As an industry, it includes over 30,000 companies and
generates $6 billion in annual revenue. Risk management is also for the individual. One
common example can be found in the financial markets. Individual investors face many risks.
5However, it's important to develop a broad understanding of risk management before looking
at the risks associated with investing. Therefore, we'll begin with a thorough overview of
general risk management and continue with a look at identifying and controlling the specific
risks associated with investing.
Risk: First Steps
10Risk is the possibility of a negative or undesired outcome. It may be as simple as the risk of
being late for an appointment because you did not leave on time. Conversely, the risk may be
more severe as would be the case if you decided to drive your car after ingesting too many
adult beverages. Here is the point: Having a risk management strategy in place ahead of time
can help control the negative outcomes.
15As implied, risk can present itself in a number of ways. If you choose to remain outside
during a thunderstorm when lightning is present, you could be struck by it. Although the
chance of being hit by lightning is low, the result could be fatal. According to the National
Weather Service, the chance of being hit by lightning in a given year is 1 in 1.9 million.
However, the odds of being struck at some point during your lifetime (assuming an 80 year
20lifespan) are 1 in 12,000.
The Steps in Managing Risk
Here is a four-step process you can follow to manage your risk.
1) Assess the Risk
2) Categorize the Risk
253) Consider Your Options
4) Implement Your Strategy
Assess the Risk
Assessing risk is determining which, if any, are present. Risks stem from hazards and a
hazard is anything which can cause harm. Leaving an open paint container in a place where a
30toddler can access it is a hazard. Leaving a loaded gun in a place where a child can get it is
another.
Categorizing Risk

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 The next step is to categorize the risk. A risk can be minor or severe. A risk can also be
common or rare. The following exhibit illustrates these principals. Notice there are four
quadrants numbered one through four. The vertical axis measures the probability that the risk
will occur and the horizontal axis measures the severity of the risk.
5Using our lightning strike mentioned earlier, the probability of it actually occurring is very
low, but the severity of it is high. Therefore, this risk would fall into category three. There are
many example of risk and each one can be categorized into one of these four quadrants. If a
risk has a high likelihood of occurring and if the consequence of it occurring would be
severe, it would be in category four. Risks which are both unlikely and minimally harmful
10would be in category one. The next step is to consider the possible methods for handling the
risk and selecting the best option.
Consider Your Options
After determining the appropriate category for a risk, the next step is to select the proper
method to address it. The following description illustrates the four primary methods for
15dealing with risk. They can be remembered with the simple acronym: ATRR or AT Railroad.
Can the risk be avoided? Can it be reduced? Can the risk be transferred? All remaining risks
must be retained.
Here's a brief description of each quadrant. Certain risks can be avoided. For example, if you
never drive drunk or skydive or bungee jump, these risks pose no threat. Again, certain risks
20can be avoided. Next, can the risk be reduced? For example, if you eat right, get plenty of
sleep, exercise, avoid unhealthy habits, etc., you may be able to reduce your chance of a
premature demise. We also realize that smoking causes lung cancer. Therefore, if we quit
smoking, we can reduce the chance of getting lung cancer. Quadrant three, transferring risk,
involves strategies such as buying insurance or lowering our deductible. By paying a
25premium, we can transfer all or part of a risk to the insurance company. Finally, for those
risks which cannot be avoided, reduced, or transferred, we have no option but to retain them.
You should never spend a lot of money to manage a risk which has a minimal consequence.
In fact, it may be best to ignore risks which fall into category one.
Conclusion
30This is a basic framework for managing risks. As mentioned, risk management is not only for
companies, but for individuals as well. In my next article, we will deal exclusively with the
risks involved in investing. Did you know there are more than 18 different risks you can face
when investing? Stay tuned for more.

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For questions 1-3, answer them by choosing the right answer A, B or C.
1. How much profit does risk management make on a yearly basis?
A. $6 million
B. $6 trillion
C. $6 billion
2. How is risk defined according to this article?
A. The likelihood of success
B. The possibility of making decisions
C. The chance of making mistakes
3. What is the odd of being hit by lightning in a 12-month period?
A. 1/2
B. 1/1,900,000
C. 1/12,000
In questions 4-8, answer them by writing no more than three words and or numbers for
each of them. An example has been done for You.
0. What is the possible outcome of being struck by lightning?
…………………….fatal……………………………
4. What is the second thing we do in order for risks to be managed?
……………………………………………………….
5. What is the word we can use to describe a situation like this: A box of medicine left
open on the floor and a child can see and approach it?
……………………………………………………….
6. How can the odds of lightning hitting a person be described?
……………………………………………………….
7. What is the term used for memorizing the four ways of dealing with risks?
……………………………………………………….
8. In what field will the risks be mentioned in the article after this one?
……………………………………………………….